Pandora Is Seeing Success With Listening Hour Cap, But That Won’t Be Enough

The total number of listener hours for Pandora Media’s (NYSE:P) Internet radio service stood at 1.31 billion for April, registering a 12% drop from March. [1] This can be attributed to the implementation of a cap on free mobile listening. Pandora’s mobile users can listen up to 40 hours of free music every month and will need to pay 99 cents to continue listening for the remainder of the month. [2] The company recently stated that the listener hour cap has started to help it control content costs. [3]

However, the flip side is that the decline in the number of listener hours would also mean lesser advertising revenues, and that’s something that investors might not be too happy about. Realistically speaking, the only way the company can reduce costs (as % of revenues) substantially is by making its mobile platform as profitable as desktop. The best way to do this is to increase direct sell-through of its mobile ad inventory. Currently, there is a huge gap between the levels of monetization on the two platforms, but the company seems to be headed in the right direction. Mobile RPM (revenue per 1,000 listener hours) has been increasing over the last few years.

Pandora’s mobile listener hours have grown tremendously over the past few years, leading to an increase in the mobile ad inventory. Close to 75-80% of the company’s total listener hours now come from the mobile platform. However, Pandora currently does not have a large enough sales force in many regional radio ad markets and establishing this sales force will be key to higher sell-through rates for its ad inventory. Over time, as the mobile listener hours growth slows, Pandora should continue pushing sales of its mobile ad inventory and eventually mobile monetization levels should catch up with current desktop levels.

Radio ad buyers are for the most part indifferent about placing their ads on the mobile or desktop platforms since traditional radio has forever been a mobile platform. Therefore, the company is confident about its ability to improve mobile monetization to sustainable levels in the future.

Long-Term Potential For Increase In Ad Frequency

Pandora serves about 8 to 12 ads per hour which can consist of 7 to 8 interaction-based display ads and 3 to 4 audio ads. In comparison, traditional radio serves around 13 minutes of advertising each hour or about 25 ad spots with each 30 seconds in duration. [1] Given that Pandora is monetizing its 8-12 hourly ads on the desktop at a rate of $57 per 1,000 listener hours, it implies that the company is monetizing better than traditional radio on a per ad basis.

What this also means is that Pandora has a significant opportunity to increase its hourly ad frequency. We believe that this has great potential in in-vehicle platforms where users are accustomed to higher ad frequency. The traditional radio market is ~$15+ billion. The in-vehicle market accounts for about 47% of the traditional radio market and therefore presents a big, untapped opportunity for Pandora.

Pandora’s Long-Term Expectations

The company had earlier stated that it expects to lower its content acquisition costs (as % of revenues) from 60% currently to 40% over the next few years. [4]

Our price estimate for Pandora stands at $9.70, implying a discount of about 30% to the market price. This price estimate is based on our expectation that Pandora’s content acquisition costs (as % of revenues) will continue to remain high and decline to just 55-56% by the end of our forecast period. However, if what Pandora is expecting is in fact possible, there could be massive upside of close to 80% to our price estimate. In other words, Pandora could be a $17 stock if the company can deliver on its promise of reducing these costs to 40% of revenues.

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